In the United States, cryptocurrencies have been the focus of much attention by both federal and state governments. At the federal level, most of the focus has been at the administrative and agency level, including the Securities and Exchange Commission (the “SEC”), the Commodity Futures Trading Commission (the “CFTC”), the Federal Trade Commission (the “FTC”) and the Department of the Treasury (the “Treasury”), through the Internal Revenue Service (the “IRS”), the Office of the Comptroller of the Currency (the “OCC”) and the Financial Crimes Enforcement Network (“FinCEN”). While there has been significant engagement by these agencies, little formal rulemaking has occurred. Many federal agencies and policymakers have praised the technology as being an important part of the U.S.’s future infrastructure and have acknowledged the need for the U.S. to maintain a leading role in the development of the technology. Beginning in 2022, and coinciding with the proliferation of cryptocurrencies in mainstream society, U.S. Congress has introduced several bills aimed at providing more clarity to the emerging sector. The bipartisan introduced Responsible Financial Innovation Act (the “RFIA”) was designed to provide regulatory clarity for agencies charged with supervising digital asset markets, provide a strong, tailored regulatory framework for stablecoins, integrate digital assets into existing tax and banking law and spur innovation in the field of digital assets. Democratic Senator Patrick Toomey introduced a bill that would create a regulatory framework for stablecoins and their issues, currently known as the Toomey Stablecoin Bill. This bill includes authorizing three options for the issuance of payment stablecoins (national limited payment stablecoin issuers, insured depository institutions and money transmitting businesses), subjecting all payment stablecoin issuers to standardized requirements, distinguishing stablecoins from securities by indicating that, at a minimum, stablecoins that do not offer interest are not securities, and applying privacy protections to transactions involving stablecoins and other virtual currencies. In the second half of 2022, bipartisan senators introduced the Digital Commodities Consumer Protection Act (the “DCCPA”), authorizing the CFTC to regulate “digital commodity platforms” and “digital commodity” trading. The DCCPA would give the CFTC exclusive jurisdiction over “digital commodity” trades, except transactions in which a merchant or consumer is using a digital commodity solely for the purchase or sale of a good or service. “Digital commodity” was defined as a fungible digital form of personal property that can be possessed and transferred person-to-person without necessary reliance on an intermediary. Two months later, Republican Senator Bill Hagerty introduced the Digital Trading Clarity Act, which provides that a digital asset not subject to a determination by the SEC or a federal court, and listed through an intermediary that meets certain requirements related to custody, disclosure, and other investor protections, would not be considered a security. In July of 2023, an updated version of the RFIA was introduced, aimed at providing greater consumer protections amid a cascading contagion of bankruptcies among blockchain companies and stakeholders. Eight days later, House Representatives Patrick McHenry, Chairman of the House Financial Services Committee, and Glenn Thompson, Chairman of the House Committee on Agriculture, introduced the Financial Innovation and Technology for the 21st Century Act (the “McHenry-Thompson Bill”), which provides a statutory framework for digital asset regulation intended to provide clarity and fill regulatory gaps. Both the House and Senate bills seek to integrate the regulation of digital assets and digital asset derivatives into the existing U.S. regulatory framework – primarily that of the SEC and CFTC – rather than create a standalone framework, discussed further below. Many state governments have proposed and/or passed laws affecting cryptocurrencies and blockchain technology, with most of the activity taking place in the legislative branch. There have generally been two approaches to regulation at the state level. Some states have tried to promote the technology by passing very favorable regulations exempting cryptocurrencies from state securities laws and/or money transmission statutes. These states hope to leverage investment in the technology to stimulate local economies and improve public services. One example, Wyoming, has been mentioned as a state seeking a broader impact on its economy. In furtherance of this objective, Wyoming passed legislation allowing for the creation of a new type of bank or special purpose depository institution. These crypto-focused banks can act in both a custodial and fiduciary capacity and are meant to allow businesses to hold digital assets safely and legally. The state also passed legislation aimed at easing the formation of decentralized autonomous organizations (“DAOs”). By issuing the DAO Supplemental Bill, Wyoming became the first state to regulate DAOs and to recognize them as a form of limited liability company (“LLC”). In its most ambitious endeavor yet, the state enacted the Wyoming Stable Token Act. This act creates a path for Wyoming to issue the U.S.’s first government-issued stablecoin, which would be fully backed by reserves of U.S. dollars. Neighboring Utah is following in Wyoming’s footsteps by enacting its own Decentralized Autonomous Organizational Act, which allows DAOs that are not registered as a for-profit corporate entity or a non-profit entity to be treated as the legal equivalent of a domestic LLC. This came after Utah allowed payments to government agencies to be made with digital assets. In what many viewed as a surprise, the governor of California vetoed the proposed Digital Financial Assets Law, which would have prohibited exchanges and other parties from digital financial asset business activity unless licensed with the state’s Department of Financial Protection and Innovation. Yet conversely, a growing number of states are making it harder for blockchain companies to operate within their borders by requiring money transmitter licenses and/or the need to strictly adhere to state blue sky securities laws. Within the past year, a number of states, including Florida, and the District of Columbia amended their money transmitter regulations to include virtual currencies/cryptocurrencies and requiring certain intermediaries to have a state-issued license. This past year also saw the rise of multistate coalitions protecting their state securities laws against some of the biggest companies in the blockchain space. On June 6, 2023, following an investigation by a task force of nine states, including California and New York, and with assistance from the SEC, each state filed enforcement actions against cryptocurrency exchange Coinbase and its parent corporation alleging that Coinbase’s staking rewards program constituted unregistered securities sales in violation of state securities laws. Another five state coalitions filed cease-and-desist orders against Nexo Inc., alleging that Nexo violated their state blue sky laws by offering unregistered securities within their state. On January 19, 2023, Nexo settled with the multistate coalitions for $22.5 million in the aggregate. A clear pattern is emerging, mirroring other industries, where bigger states with bigger economies clearly intend to regulate blockchain technology, whereas smaller states seek to be a regulatory refuge for blockchain stakeholders. There is no uniform definition of “cryptocurrency,” which is often referred to as “virtual currency,” “digital assets,” “digital tokens,” “cryptoassets” or simply “crypto.” The Uniform Law Commission and the American Law Institute amended the Uniform Commercial Code to include Article 12, which defines and governs digital assets specifically. The new article includes virtual currencies in its definition of “controllable electronic records.” Several states have already adopted the amendment. Other jurisdictions have attempted to formulate a detailed definition for the asset class, most have wisely opted for broader, more technology-agnostic definitions. Those taking the latter approach will be better positioned to regulate as and when the technology evolves. The Biden Administration released an Executive Order (“EO”) outlining an approach to address risks stemming from the growth of digital assets and blockchain technology while supporting responsible innovation. The EO focuses on six key priorities: (1) consumer and investor protection; (2) financial stability; (3) illicit finance; (4) U.S. leadership in the global financial system and economic competitiveness; (5) financial inclusion; and (6) responsible innovation. To advance these key priorities, the EO called for a number of reports, studies and plans, including reports from the Treasury, on: (1) the future of money and potential impacts of a U.S. central bank digital currency (“CBDC”); and (2) policy recommendations around consumer protection and financial inclusion issues. It also calls for the Financial Stability Oversight Council to produce a report on financial stability risks and regulatory gaps. In response to the EO, the White House released a fact sheet designed to provide a comprehensive framework for regulating digital assets based on input from various U.S. government agencies and departments. The framework greenlights regulators such as the SEC and CFTC to continue coordinating efforts to enforce law in the industry and to share data on consumer complaints in the space. The Treasury will take an active role in working with financial institutions to help identify and mitigate cyber risks through data sharing and analysis. It is also tasked with working with regulators to ensure that crypto firms have regulatory guidance. The fact sheet also mentions a potential U.S. CBDC, citing many potential benefits in technology, the economy, security and individual liberty. On March 20, 2023, the White House published the 2023 Economic Report of the President, which, for the first time, includes an entire 35-page chapter on digital assets. It provides a number of pointed criticisms of cryptocurrency – an apparent shift from the previous approach of the Biden Administration articulated in the EO. The report states that cryptoassets currently do not offer widespread economic benefit. Additionally, the report claims that cryptoassets are mainly a speculative investment vehicle and not an effective alternative to fiat currency. It acknowledged that some cryptoassets are here to stay, and states that much of the activity in the cryptoasset space is covered by existing regulations. The SEC generally has regulatory authority over the issuance or resale of any token or other digital asset that constitutes a security. Under U.S. law, a security includes “an investment contract,” which has been defined by the U.S. Supreme Court as an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946). In determining whether a token or other digital asset is an “investment contract,” both the SEC and the courts look at the substance of the transaction, instead of its form. In 1943, the U.S. Supreme Court determined that “the reach of the [Securities] Act does not stop with the obvious and commonplace. Novel, uncommon, or irregular devices, whatever they appear to be, are also reached if it be proved as matter of fact that they were widely offered or dealt in under terms or courses of dealing which established their character in commerce as ‘investment contracts,’ or as ‘any interest or instrument commonly known as a ‘security’.” SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351 (1943). It has also been said that “Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.” Reves v. Ernst & Young, 494 U.S. 56, 61 (1990). Certain market professionals have attempted to highlight the utility or voucher-like characteristics of their proposed ICOs in an effort to claim that their proposed tokens or coins are not securities. Many of these assertions that the federal securities laws do not apply to a particular ICO appear to elevate form over substance. The rise of these form-based arguments is a disturbing trend that deprives investors of mandatory protections that clearly are required as a result of the structure of the transaction. Merely calling a token a ‘utility’ token or structuring it to provide some utility does not prevent the token from being a security. Returning to the ICOs I am seeing, strictly speaking, the token – or coin or whatever the digital information packet is called – all by itself is not a security, just as the orange groves in Howey were not. Central to determining whether a security is being sold is how it is being sold and the reasonable expectations of purchasers. When someone buys a housing unit to live in, it is probably not a security. But under certain circumstances, the same asset can be offered and sold in a way that causes investors to have a reasonable expectation of profits based on the efforts of others. For example, if the housing unit is offered with a management contract or other services, it can be a security. Later in the same speech, Mr. Hinman made clear that a digital token that might initially be sold in a transaction, constituting the sale of a security, might thereafter be sold as a non-security where the facts and circumstances have changed over time, such that the Howey test is no longer met, specifically, if the blockchain protocol becomes truly decentralized like Bitcoin and Ethereum; negating the “efforts of others” prong of Howey. While such comments are not official policy of the SEC, they are a good indicator of it. If a digital asset is determined to be a security, then the issuer must register the security with the SEC or offer it pursuant to an exemption from the registration requirements. For offerings that are being made under a federal exemption from securities registration, the SEC places fewer restrictions on the sale of securities to “accredited investors.” An individual investor is an “accredited investor” only if he or she (i) is a director or executive officer of the company issuing the securities, (ii) has an individual net worth (or joint net worth with a spouse) that exceeds $1 million, excluding the value of the investor’s primary residence, (iii) has an individual income that exceeds $200,000 in each of the two most recent years, and has a reasonable expectation of reaching the same individual income level in the current year, or (iv) has a joint income that exceeds $300,000 in each of the two most recent years, and has a reasonable expectation of reaching the same joint income level in the current year. See SEC Rule 501(a)(5). Significant enforcement actions by the SEC have included actions brought against Telegram and Kik. These actions highlight the SEC’s willingness to aggressively enforce U.S. securities laws in cases involving digital assets. In October 2019, the SEC filed a complaint against Telegram alleging that the company had raised $1.7 billion through the sale of 2.9 billion GRAMS (the company’s native cryptocurrency) to finance its business. GRAMS were to allow customers of the messaging service to use the token as a means of payment for goods and services within the Telegram ecosystem. The SEC sought to enjoin Telegram from delivering the GRAMS it sold, which, using the Howey test, the regulator alleged were securities and were not properly registered. In March of 2020, the U.S. District Court for the Southern District of New York (“SDNY”) issued a preliminary injunction. The SEC argued that the Simple Agreement for Future Tokens (“SAFT”) – mirrored after the commonly used Simple Agreement for Future Equity – and the subsequent resale of GRAMS delivered pursuant to the SAFT, could not be viewed as two isolated phases, but rather should be viewed holistically as a single integrated scheme to issue securities that yield a profit. Ultimately, Telegram abandoned its plan to issue the GRAMS tokens, and agreed to repay the $1.2 billion to investors and pay an $18.5 million civil penalty. The SEC’s position could make it more difficult for token issuers to bifurcate between capital-raising activities and the bona fide sale of tokens intended to provide some utility other than as an investment. In October 2020, a federal district court entered a final judgment against Kik Interactive Inc. (“Kik”) relating to Kik’s unregistered offering of digital “Kin” tokens in 2017, which the SEC argued violated U.S. securities laws. More specifically, the SEC alleged that Kik sold securities to U.S. investors without a valid registration as required under U.S. securities laws. The court found that sales of “Kin” tokens constituted investment contracts; and hence, were securities. Kik had argued that its private sales were limited to accredited investors, but the court held that even those sales did not qualify for an exemption because its private and public sales were a single integrated offering. As part of the final judgment, Kik agreed to pay a $5 million penalty. In December 2020, the SEC announced that it filed an action in the SDNY against Ripple Labs, Inc., alleging that it raised over $1.3 billion through an ongoing unregistered digital asset securities offering. The complaint alleged that Ripple raised funds, beginning in 2013, through the sale of the XRP digital coin in an unregistered securities offering to investors in the U.S. After the SEC’s announcement, most major U.S. crypto exchanges, including Coinbase, delisted or halted trading of XRP. However, defendants maintained their assertion that XRP is a cryptocurrency and does not need to be registered as an investment contract. In March 2022, the SDNY denied the SEC’s motion to strike Ripple’s “fair notice” defense. Ripple asserted that the SEC failed to provide Ripple with fair notice that its unregistered sales of XRP violated federal law. Among other things, Ripple asserted that the SEC failed to take action in 2015 when Ripple reached a settlement with the U.S. Department of Justice (“DOJ”) and the Treasury’s FinCEN, which described XRP as a “convertible virtual currency,” permitting future sales of XRP subject to laws and regulations applicable to MSBs. On July 13, 2023, the court issued its order granting in part and denying in part cross motions for summary judgment filed by both parties, holding that, under the Howey test, unregistered sales of XRP to retail investors on digital asset exchanges did not constitute the offer and sale of cryptoasset securities under the U.S. securities laws, while sales of XRP to institutional investors were prohibited offers and sales. The court held that programmatic sales of XRP to retail investors on digital asset exchanges did not constitute the offer and sale of securities because these sales were blind bid/ask transactions and retail buyers could not have known whether their payments of money went to Ripple or another unaffiliated intermediary. Sales of XRP to institutional investors did constitute the offer and sale of securities because institutional investors would have purchased XRP with the expectation that they would derive profits from Ripple’s efforts, and Ripple led institutional investors to believe it would use the capital received from its institutional sales to improve the market for XRP and develop uses for the XRP ledger, thereby increasing the value of XRP. However, this ruling was quickly challenged by another judge sitting on the same bench. It may also be mentioned that the Court declines to draw a distinction between these coins based on their manner of sale, such that coins sold directly to institutional investors are considered securities and those sold through secondary market transactions to retail investors are not. In doing so, the Court rejects the approach recently adopted by another judge of this District in a similar case[.] Simply put, secondary market purchasers had every bit as good a reason to believe that the defendants would take their capital contributions and use it to generate profits on their behalf. Note that the Terraform decision must be considered in the context of the defendants’ motion to dismiss, and the court’s obligation in determining such a motion, generally, to consider all allegations of the SEC as true. The Ripple decision, by contrast, came on cross-motions for summary judgment after extensive fact and expert discovery had occurred. The Terraform case will proceed to the discovery phase. The outcomes of the Telegram, Kik and Ripple Labs proceedings make it incredibly difficult to consummate most token-generating events involving U.S. persons. Many issuers have opted to exclude U.S. persons from token offerings, and instead have elected to limit sales to non-U.S. persons (e.g., pursuant to the Regulation S safe harbor). Two other implications for a token constituting a security are (i) the requirement that a person be a broker-dealer licensed with the SEC and a member of the Financial Industry Regulatory Authority (“FINRA”) in order to facilitate the sale of securities or to act as a market maker or otherwise constitute a dealer in the asset, and (ii) the asset can only trade on a licensed securities exchange or alternative trading system (“ATS”) approved by the SEC. Several exchanges attained approval as an ATS and several firms have been registered as a broker-dealer, in each case, with the intent to deal in cryptocurrencies that are considered securities. To date, however, there are only a handful of security tokens actively trading on these ATS platforms. This is likely the result of the difficulties in integrating traditional securities laws around the transfer of securities and the notion of a peer-to-peer network that seeks to operate without intermediaries. exchanges include not only organizations, associations, or groups of persons that provide trading facilities or set rules, but also organizations, associations, or groups of persons that merely provide communication protocols. These proposed amendments, which deformalize the criteria for being an exchange, have clear and potentially profound implications for decentralized finance (“DeFi”). Under the proposed definition of exchange, an organization, association, or group of persons that passively makes available a communication protocol under which buyers and sellers with trading interest can interact and agree on the terms of trades is an exchange. earning revenue primarily from capturing bid-ask spreads, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity-supplying trading interests. In addition to covering proprietary traders in equities, fixed income, and other traditional financial assets, the proposal may lead to a dealer registration requirement for automated market makers and other liquidity providers in the cryptocurrency and DeFi space. Between the exchange and dealer proposals, a staggering number of companies and software developers in the crypto and DeFi space may become subject to the SEC’s broker-dealer framework, including registration with the SEC and FINRA membership. In a certain way, this outcome would be consistent with SEC’s long-enunciated approach that it will employ the existing laws and regulatory framework to new technologies. Proving a viable path towards registration and membership, on May 17, 2023, Prometheum Ember Capital LLC (“Prometheum”) received approval from FINRA to operate as a special purpose broker-dealer (“SPBD”) for digital assets. Prometheum is the first SPBD allowed to operate as a broker-dealer and as a qualified custodian in the U.S. This approval follows guidance issued by the SEC permitting an SPBD to custody digital assets so long as it complies with Securities Exchange Act Rule 15c3-3 (the Customer Protection Rule). This SPBD addresses the lack of investor protection in the digital assets space by offering both retail and institutional investors an opportunity to custody their digital assets with an SEC-registered SPBD and a FINRA member firm. In July 2022, the DOJ and the SEC each brought insider trading charges against a former Coinbase product manager for using material non-public information to purchase a variety of cryptoassets prior to announcements by Coinbase that the assets would be listed on the company’s platform. The SEC’s allegation that the product manager violated Section 10(b) and Rule 10b-5 of the Exchange Act requires that the tokens traded were securities. Significantly, while the SEC alleges that the manager used material, non-public information to purchase 25 different digital assets ahead of listing announcements, the complaint only alleges that nine of the assets were securities. The other 16 are not even identified, let alone alleged to be securities. Coinbase has strongly challenged the notion that any of the cryptoassets on its platform are securities. Commissioner Pham also urged the CFTC to take a leading role in this space, which highlights the tension between the SEC and CFTC as to who should regulate digital assets. In an effort to harmonize digital asset regulation, the proposed Digital Trading Clarity Act aims to provide regulatory clarity around two primary concerns plaguing crypto exchange establishments: (i) the classification of digital assets; and (ii) related liabilities under existing securities laws. If determined by a federal court through a final judgment, or the SEC through formal rulemaking or enforcement action, and without objection from the CFTC, that a digital asset is a security, the bill requires the SEC Division of Examinations to request information from an intermediary listing that asset to determine whether the intermediary meets the requirements in the bill text. If it does, the intermediary and digital asset enter into a two-year “compliance period” in which the intermediary would not be subject to enforcement actions for listing that asset or failing to register as a national securities exchange or broker-dealer in connection with that asset. In September 2022, SEC Chair Gary Gensler indicated in a speech at a Practising Law Institute SEC Speaks event, and again on September 15, 2022 in congressional testimony, that certain crypto intermediaries must register with the SEC. Gensler also offered support for CFTC regulation of “non-security” tokens. In July 2023, an updated version of the RFIA – first introduced in 2022 – attempts to codify a clear regulatory framework for which cryptoassets are securities or commodities. Under the RFIA, the CFTC would have exclusive jurisdiction over a crypto token that qualifies as an ancillary asset but not the “security that constitutes an investment contract.” To qualify as an ancillary asset, the token must not offer the holder any financial rights in a business, such as to debt or equity, liquidation, or interest or dividend payments. The SEC, however, would have a role to play: where the average daily aggregate value of transactions in the ancillary asset exceeds a certain threshold, and where the issuer engaged in “entrepreneurial or managerial efforts that primarily determined the value of the ancillary asset,” the issuer would be required to file detailed disclosures with the SEC. In the same vein, the McHenry-Thompson Bill gives the CFTC primary jurisdiction over digital asset markets but details a process for market participants and regulators to follow in allocating oversight of digital assets between the SEC and CFTC. A digital asset is classified as a “digital commodity” and is regulated by the CFTC if the blockchain network to which a digital asset relates is both “functional” and certified as “decentralized.” Any person (whether or not related to the network’s development) may certify an asset’s status as a digital commodity. Networks are presumed decentralized unless the SEC objects within 30 days of the certification and provides a detailed analysis of its reasons for doing so. The SEC would regulate “restricted digital assets,” which are: (i) digital assets held by the issuer of the digital asset or affiliates before the networks to which the assets relate are functional and certified as decentralized (known as a premining); and (ii) digital assets held by persons other than issuers or affiliates before the networks to which the assets relate are functional and certified as decentralized, unless the digital assets are distributed through an “end user distribution” or acquired on a CFTC-regulated exchange. In response to the Ripple decision, both Republican and Democratic members of Congress sent letters to the SEC, urging the agency to reassess its strategy. If the courts rule against the SEC in other cases, as occurred in Terraform, Congress might feel more urgency to enact legislation to resolve legal ambiguities between administrative agencies. Under the Bank Secrecy Act (the “BSA”), FinCEN regulates MSBs. On March 18, 2013, FinCEN issued guidance that stated the following would be considered MSBs: (i) a virtual currency exchange; and (ii) an administrator of a centralized repository of virtual currency who has the authority to both issue and redeem the virtual currency. FinCEN issued guidance that stated as follows: “An administrator or exchanger that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN’s regulations, unless a limitation to or exemption from the definition applies to the person.” See FIN-2013-G001, Application of FinCEN’s Regulations to Persons Administering, Exchanging or Using Virtual Currencies (March 18, 2013). An MSB that is money transmitter must conduct a comprehensive risk assessment of its exposure to money laundering and implement an anti-money laundering (“AML”) program based on such risk assessment. FinCEN regulations require MSBs to develop, implement, and maintain a written program that is reasonably designed to prevent the MSB from being used to facilitate money laundering and the financing of terrorist activities. The AML program must: (i) incorporate written policies, procedures and internal controls reasonably designed to assure ongoing compliance; (ii) designate an individual compliance officer responsible for assuring day-to-day compliance with the program and BSA requirements; (iii) provide training for appropriate personnel, which specifically includes training in the detection of suspicious transactions; and (iv) provide for independent review to monitor and maintain an adequate program. All U.S. persons are prohibited from doing business with foreign nationals who are on the Specially Designated Nationals and Blocked Entities List (“SDN List”) of the Treasury’s Office of Foreign Assets Control (“OFAC”). OFAC provides an updated and searchable version of its SDN List at: https://sanctionssearch.ofac.treas.gov . OFAC requires all U.S. citizens to “block” (i.e., freeze) the assets of individuals and companies who are engaging in transactions with (i) countries that are subject to U.S. economic sanctions, (ii) certain companies and entities that act as agents for such countries, and (iii) certain individuals that act as agents for such countries. It is important to have a compliance program in place to avoid (or mitigate) receiving civil and criminal penalties from OFAC for non-compliance. See 31 C.F.R. Part 501 (OFAC Reporting Regulations); OFAC Economic Sanctions Enforcement Guidelines (November 9, 2009). On February 13, 2018, in response to a letter from Senator Ron Wyden, an official within the Treasury issued a correspondence that called into question whether ICO issuers were de facto MSBs that were required to register with FinCEN. While there were several flaws in the logic set forth in the letter, it remains an area of concern for anyone considering a token sale. To add more confusion, speaking at a conference on November 19, 2019, FinCEN Director Kenneth Blanco, responding to a question about Facebook’s plan to issue a cryptocurrency pegged to the U.S. dollar, stated that stablecoin issuers and dealers are money transmitters and must follow the BSA’s AML laws. State laws on money transmission vary widely but can generally be grouped into a few categories. Most states define money transmission as including some or all of three types of activities: (1) money transmission; (2) issuing and/or selling payment instruments; and (3) issuing and/or selling stored value. A few states only regulate these activities when “money” is involved, and define money as “a medium of exchange that is authorized or adopted by a domestic or foreign government.” Generally, state money transmission laws apply to any entity that is either located in the state or is located outside of the state (including in a foreign jurisdiction) but does business with residents of the state. A novel solution to the redundancy of attaining state licenses is to become a New York limited purpose trust company. This may seem counterintuitive, as New York has the most onerous money transmitter licensing requirements for cryptocurrency companies, but this type of trust company charter exempts the company from many states’ money transmission laws and requirements, while also providing the ability to conduct a broad range of custody and fiduciary services related to cryptoassets. Nevada and Wyoming have since followed New York and now permit the creation of special purpose depository institutions. Another tension point for AML laws is the emergence of DeFi. DeFi is the permissionless decentralization version of various traditional financial instruments with a focus on exchanging assets, lending and borrowing and the creation of synthetic assets. For example, Uniswap is a decentralized exchange in the form of four smart contracts hosted on the Ethereum blockchain, as well as a public, open-source, front-end client. This ultimately allows for anyone with an internet connection to trade many Ethereum-native tokens with other users of the application. Inherent with its open-source nature, Uniswap does not have a customer identification vetting process and, in fact, circumventing AML laws is touted as one of Uniswap’s foundational values among the cryptocurrency community. According to official data, over $620 billion of transactions occurred using the Uniswap Protocol in 2022. In September 2021, it was reported that the SEC had begun an investigation into Uniswap Labs and its Uniswap Protocol. This investigation is apparently ongoing. Despite public assurances otherwise, Tornado Cash has repeatedly failed to impose effective controls designed to stop it from laundering funds for malicious cyber actors on a regular basis and without basic measures to address its risks. Treasury will continue to aggressively pursue actions against mixers that launder virtual currency for criminals and those who assist them. Nelson’s words make it clear that cryptocurrency services, whether they are decentralized or not, must at least make an effort to implement controls to prevent bad actors from abusing them. In November 2022, OFAC settled with Kraken, a crypto exchange, for apparent violations of OFAC sanctions against Iran. According to the settlement letter, while Kraken maintained controls intended to prevent users from initially opening an account while in a sanctioned jurisdiction, it did not implement IP address blocking on transactional activity across its platform, allowing account holders who established their accounts outside of sanctioned jurisdictions to apparently access their accounts and transact on Kraken’s platform from a sanctioned jurisdiction. Additionally, in 2023, OFAC issued an enforcement release announcing settlement of charges against virtual currency exchange Poloniex, under which Poloniex agreed to pay $7,591,630 for processing transactions totaling $15,335,349 between January 2014 and November 2019 in apparent violation of U.S. economic sanctions against Crimea, Cuba, Iran, Sudan, and Syria. In March 2014, the IRS declared that “virtual currency,” such as Bitcoin and other cryptocurrency, will be taxed by the IRS as “property” and not currency. See IRS Notice 2014-21, Guidance on Virtual Currency (March 25, 2014). Consequently, every individual or business that owns cryptocurrency will generally need to, among other things, (i) keep detailed records of cryptocurrency purchases and sales, (ii) pay taxes on any gains that may have been made upon the sale of cryptocurrency for cash, (iii) pay taxes on any gains that may have been made upon the purchase of a good or service with cryptocurrency, and (iv) pay taxes on the fair market value of any mined cryptocurrency, as of the date of receipt. For an individual filing a federal income tax return, the gains or losses from a sale of virtual currency that was held as a “capital asset” (i.e., for investment purposes) are reported on (i) Schedule D of IRS Form 1040, and (ii) IRS Form 8949 (Sales and Other Dispositions of Capital Assets). Any realized gains on virtual currency held for more than one year as a capital asset by an individual are subject to capital gains tax rates. Any realized gains on virtual currency held for one year or less as a capital asset by an individual are subject to ordinary income tax rates. The IRS requires, on Form 8949, for each virtual currency transaction, the following information be disclosed: (i) a description of the amount and type of virtual currency sold; (ii) the date acquired; (iii) the date the virtual currency was sold; (iv) the amount of proceeds from the sale; (v) the cost (or other basis); and (vi) the amount of the gain or loss. It should be noted that the record-keeping requirements of IRS Form 8949 can be particularly onerous for those who have used cryptocurrency to make numerous small purchases of goods or services throughout the year. For transactions completed on or prior to December 31, 2017, the IRS has not issued any guidance on whether different cryptocurrencies are “property of like kind” that would qualify for non-recognition of gain under Section 1031(a). Generally speaking, exchanges between different cryptocurrencies are usually done by either (i) a simultaneous swap of one cryptocurrency for another, or (ii) a deferred exchange, in which one cryptocurrency is sold for cash, followed by the purchase for cash, of a different cryptocurrency. For transactions completed on or prior to December 31, 2017, Section 1031(a)(1) of the Internal Revenue Code states the following: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.” In 26 C.F.R. 1.1031(a)-2(b), “like kind” is defined as follows: “As used in section 1031(a), the words like kind have reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under that section, be exchanged for property of a different kind or class.” It should be noted that, in order to attempt to utilize the tax treatment of Section 1031(a) for transactions done on or prior to December 31, 2017, (i) each transaction must comply with certain requirements set forth in IRS regulations (such as the use, in certain instances, of a “qualified intermediary”), and (ii) the taxpayer must file a Form 8824 with the IRS. With respect to digital assets acquired via a hard fork or airdrop, the IRS issued Rev. Rul. 2019-24. Pursuant to this revenue ruling, the IRS confirmed that the new assets resulting from such events can result in revenue to the taxpayer. The IRS also concluded, however, that a taxpayer does not have gross income as a result of a hard fork if it does not receive the new cryptocurrency. In April 2021, the IRS released Chief Counsel Advice memo 202114020 (Hard Fork CCA) that specifically addressed the tax consequences of the 2017 hard fork that created Bitcoin Cash. The IRS concluded that a taxpayer who received Bitcoin Cash as a result of the hard fork had realized gross income. The IRS further concluded that when the taxpayer obtained “dominion and control” over the Bitcoin Cash would determine, for tax purposes, its date of receipt and the determination of its fair market value. In November 2021, President Biden signed into law the Infrastructure Investment and Jobs Act (“IIJA”), which will require digital asset brokers to report to the IRS digital asset transactions valued at more than $10,000. IIJA defines the term “broker” broadly, which could subject parties that are peripheral to digital asset transactions, including cryptominers, software developers, and parties validating cryptocurrency transactions or selling cryptocurrency storage devices, to the reporting and compliance requirements of IIJA. In February 2022, the Treasury indicated that it is inclined to adopt a narrow interpretation of the term “broker” in the context of IIJA, which would limit compliance requirements for digital asset transactions to parties that can provide information useful to the IRS. These rules are scheduled to take effect in January 2024. In September 2022, Ethereum made the transition from a power-hungry, proof-of-work system (“PoW”) to an environmentally friendly proof-of-stake system (“PoS”) that uses over 99.9% less energy. This historic event was called “The Merge.” The Merge changed the way that Ethereum transactions were validated. Using PoW, Ethereum worked like Bitcoin: transactions were mined by a decentralized network of computers, which raced to solve mathematical puzzles and were rewarded with new coins for doing so. Now, transactions are conducted on the new PoS network and new Ether will be minted by nodes on the network staking a fair amount of Ether tokens into a pool to secure the network and validate transactions. For its part, the IRS has published guidance regarding the treatment of cryptocurrency staking rewards. In Rev. Rul. 2023-14, the IRS clarifies that when taxpayers stake cryptocurrency and receive validation rewards, the fair market value of the rewards must be included in the taxpayers’ gross income for the taxable year when the taxpayer gains control over the rewards. A taxpayer has control over rewards once the taxpayer gains the ability to sell, exchange, or dispose of the received units. Arizona became the first state in the U.S. to adopt a “regulatory sandbox” to shepherd the development of new emerging industries like fintech, blockchain and cryptocurrencies within its borders. The law grants regulatory relief for innovators in these sectors who desire to bring new products to market within the state. Under the program, companies are able to test their products for up to two years and serve as many as 10,000 customers before needing to apply for formal licensure. Other states have since followed suit and created similar programs including Wyoming, Florida, Utah, West Virginia, Kentucky, Vermont, Nevada and Hawaii. Cryptocurrency fund managers that invest in cryptocurrency futures contracts, as opposed to “spot transactions” in cryptocurrencies, are required to register as a commodity trading advisor (“CTA”) and commodity pool operator (“CPO”) with the CFTC and with the National Futures Association (the “NFA”), or satisfy an exemption. Also, because of additions to the Dodd-Frank Act, cryptocurrency hedge fund managers that use leverage or margin would also need to register with the CFTC and NFA. The Dodd-Frank Act amended the Commodities Act to add new authority over certain leveraged, margined, or financed retail commodity transactions. The CFTC exercised this jurisdiction in an action against BFXNA INC. d/b/a BITFINEX in 2016. Fund managers should be cautious when using margin/leverage as it may require them to register as a CTA and CPO with the CFTC and register with the NFA. In April 2022, FalconX, a prime broker for digital assets that provides institutional investors access to the over-the-counter crypto derivatives market, announced that it has become the first cryptocurrency swap dealer registered with the NFA. Quashing an industry-wide perception that DeFi actors are immune to regulatory scrutiny, in 2023, a federal judge in the U.S. District Court of the Northern District of California ruled that a DAO violated the CEA. In a precedent-setting decision, the court held that the defendant, Ooki DAO, is a “person” under the CEA and can thus be held liable for violations of the law, engaging in unlawful off-exchange leveraged and margined retail commodity transactions, soliciting and accepting orders for leveraged or margined retail commodity transactions with customers, and accepting money or property to margin those transactions. The CEA assigns liability to “[a]ny person” who takes particular actions and defines “person” to include “individuals, associations, partnerships, corporations, and trusts.” However, the CEA does not further define “association.” The court noted that it had previously found that the CFTC sufficiently pleaded facts showing that Ooki DAO is an unincorporated association. Although that holding was in the context of a service of process issue, the court said those definitions were not limited to service provision. Thus, for those same reasons, the CFTC’s complaint established Ooki DAO as an unincorporated association under state and federal law. The Investment Company Act of 1940 (the “Company Act”), the Investment Advisers Act of 1940 (the “Advisers Act”), as well as state investment advisor laws, impose regulations on investment funds that invest in securities. The Company Act generally requires investment companies to register with the SEC as mutual funds unless they meet an exemption. Cryptocurrency funds, and hedge funds generally, can be structured under one of two exemptions from registration under the Investment Company Act. Section 3(c)(1) allows a fund to have up to 100 investors. Alternatively, Section 3(c)(7) allows a fund to have an unlimited number of investors (but practically it should be limited to 2,000 to avoid being deemed a publicly traded partnership under the Securities Exchange Act) but requires a significantly higher net worth suitability requirement for each investor (roughly $5 million for individuals, $25 million for entities). As a general rule, most startup funds are structured as 3(c)(1) funds because of the lower investor suitability requirements. Until the SEC provides more guidance on classifying individual cryptocurrencies as securities or commodities, the likelihood of many cryptocurrencies being deemed securities is high. As such, we recommend that cryptocurrency funds that invest in anything other than Bitcoin, or Ether, and the handful of other clearly commodity coins, comply with the Company Act preemptively. For most startup funds, this would mean limiting investors within a given fund to fewer than 100 beneficial owners. Regardless of whether a startup cryptocurrency fund manager is required to register as a CPO/CTA with the CFTC under the Commodities Act, or register or seek exemption from the SEC as an investment advisor (under the Advisers Act), or investment company (under the Company Act), every cryptocurrency fund manager will be subject to the fraud provisions of the CFTC and/or the SEC. In September 2017, the CFTC announced its first anti-fraud enforcement action involving Bitcoin. These anti-fraud actions can be taken by the SEC and CFTC regardless of the cryptocurrency fund’s exempt status. In July of 2020, the OCC affirmed in an interpretive letter that national banks and savings associations can provide custody services for cryptocurrency. The letter noted that banks can also provide related services such as cryptocurrency-fiat exchanges, transaction settlement, trade execution, valuation, tax services and reporting. The effort supplements a patchwork of state regulation and guidance that to date has encouraged only a select few national banks and financial services companies to embrace cryptocurrency (see above: Money transmission laws and anti-money laundering requirements). While the OCC agreed that underlying keys to a unit of cryptocurrency are essentially irreplaceable if lost, it said that banks could be a part of the solution by offering more secure storage services compared to existing options. The development of cryptocurrency and other popular blockchain applications has captured the attention of energy and environmental policymakers, global economists, and renewables industry players. Now home to over a third of the global computing power dedicated to mining Bitcoin, the U.S. has turned its attention to domestic miners and their impacts on the environment and local economies. On January 20, 2022, the U.S. House of Representatives Committee on Energy and Commerce’s Subcommittee on Oversight and Investigations held a hearing, where the externalities of cryptocurrency mining were the focus of the agenda. An early indicator of the Subcommittee’s views on the issue, the title for the hearing was “Cleaning up Cryptocurrency: The Energy Impacts of Blockchains.” As the federal government studies the viability of crypto mining at a national level, states have been active in regulating crypto mining. In June 2022, the New York State Senate passed Senate Bill S6486D, which would establish a two-year moratorium on cryptocurrency mining operations that use PoW authentication methods to validate blockchain transactions in the state of New York. If signed into law, the bill would require comprehensive generic environmental impact review and effectively suspend all blockchain mining operations running on carbon-based power sources. Conversely, the Oklahoma Senate introduced Bill 590, which would establish the Commercial Digital Asset Mining Act of 2022 to provide certain tax exemptions for the sale of certain crypto mining equipment and machinery. Kentucky also enacted certain state-tax exemptions for cryptocurrency miners and mining facilities. A group of U.S. lawmakers has proposed a requirement that individuals declare their cryptocurrency holdings when entering the U.S., but to date no such requirement has gone into effect. On December 31, 2020, FinCEN issued a notice stating that it intends to amend regulations implementing the BSA to include virtual currencies as a type of reportable account for the requirement to file a Report of Foreign Bank and Financial Accounts. Cryptocurrency, such as Bitcoin, has value and therefore is increasingly likely to become an estate asset. While there are few, if any, laws specific to cryptocurrency, due to the nature of cryptocurrencies, typical wills and revocable living trusts may not be well suited to efficiently transfer this new type of asset. Consequently, new estate planning questions and clauses may be needed. While cryptocurrency is not sufficiently mature to allow existing legal structures to promulgate a complete set of rules and regulations, cryptocurrency’s technological character allows estate planning to protect the intent of clients holding cryptocurrency. However, the lack of statutory structure necessitates proactive steps. Accordingly, someone who wants greater certainty of bequeathing cryptocurrency to their heirs will need to provide specific and detailed written instructions in your estate planning documents. The information they will need to include will depend upon the type of virtual currency wallet they have. There are a wide range of cryptocurrency wallets that are available at this time. The current types of cryptocurrency wallets include: (i) a single device software wallet in which you hold the private keys (example: BitPay Wallet), (ii) a multiple device web wallet in which you hold the private keys (example: Blockchain Wallet), (iii) a multiple device web wallet in which you do not hold the private keys (example: Coinbase Wallet), (iv) a USB hardware dongle wallet in which you hold the private keys (example: Trezor Wallet), and (v) a “paper wallet” in which the private keys and public keys are written down (which can be later loaded into a software wallet of your choice to be spent). The instructions that you provide in a will (for your personal representative) or in a declaration of trust (for the successor trustee of a revocable living trust) should be written in a manner that is easy to understand for individuals who are not familiar with cryptocurrency. For example, in the case of a single device software wallet in which you hold the private keys, instructions could include (i) a description of the name and version of the wallet software, (ii) a description of the name and version of the operating software system of the wallet device (i.e., iOS, Android, macOS, Windows or Linux), (iii) a description of the types of virtual currency held by the wallet, (iv) either the long-form private and public keys for the wallet or the 12-word “seed” BIP39 or BIP44 recovery phrase for the wallet, and (v) step-by-step instructions (which may include screenshots) showing how the wallet can be restored onto a new device, if the current wallet device cannot be accessed. As transfers from a Bitcoin wallet and most other wallets are irrevocable, private key information about your cryptocurrency accounts will need to be kept in a secure manner. Security can be enhanced by storing the private key information in a safe-deposit box or vault, which could only be accessed after your death by the personal representative designated in your will (or the successor trustee designated in your revocable living trust). This chapter has been written by a member of Gli’s international panel of experts, who has been exclusively appointed for this task as a leading professional in their field by Global Legal Group, Gli’s publisher. Gli’s in-house editorial team carefully reviews and edits each chapter, updated annually, and audits each one for originality, relevance and style, including anti-plagiarism and AI-detection tools.